The importance of cash flow disclosure and cost of capital

We examine whether the choice of cash flow disclosure under International Accounting Standard 7 has an influence on the cost of capital incurred by Australian listed companies. Results indicate that indirect method companies incur a significantly higher ex-ante cost of equity than direct method companies using a combined equity model approach. We also demonstrate that using an optimal weighted combination of equity models reduces model variance and bias compared to using a single equity model. Our findings support mandating the direct method and have the potential to induce companies to report the direct method to increase company value.